ValuePickr Forum

Asset Management/Wealth Management Industry - 25 year bet

Hi all,

Perhaps this is already being discussed in some of the other posts, but I wanted to bring special focus on to this. The asset management industry in my view is poised to grow at a healthy rate over the next 25 years. This space is still very nascent in India and I am embarking on a detailed study on understand the industry, the different businesses within this space, the critical success factors and the key data points to follow. Some of my initial thoughts and notes below, please feel free to chip in. (Much of the data I will refer to below are from the HDFC AMC IPO Prospectus, if you are interested please feel free to read that report)

INDUSTRY

The asset management (mutual fund) industry in India has 41 players in total. A total of Rs.23 Trillion is being managed by these funds. The top 5 players and their market share are as below. June 2018 AUM is in trillions of Indian rupees. (The numbers are so mindbogglingly big that it is difficult to get heads around this; and the constant switching between Indian and international numeric system makes it even more complicated!)

Mutual Fund Name June 2018 AUM June 2018 Mareket Share
ICICI Prudential Mutual Fund 3.1 13.26%
HDFC Mutual Fund 3.07 13.12%
Aditya Birla Sun Life Mutual Fund 2.5 10.66%
Reliance Mutual Fund 2.4 10.28%
SBI Mutual Fund 2.3 9.97%

The overall AUM of this industry has grown 20X in the last 18 years. However much of the increase has happened in the last 5 years or so. So from a business cycle perspective, we are possibly at the peak of the most recent cycle. This is understandable given how much the equity markets have gone up in the same period.

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However, what is interesting is that the total number of fund houses has only grown from 32 at the end of FY-2000 to 41 at the end of FY18. My guess is because of the nature of the economics of running this business. The larger the size, the higher the operational efficiencies. But more on that later.

Product/Service Offering

Principally, there are 3 types of product offering

  1. Actively managed equity funds
  2. Non-equity oriented debt funds
  3. Portfolio management and segregated account services

Then there are a combination of these - Hybrid funds, ETF, open ended and closed ended funds, index linked funds, arbitrage funds and the list is endless.

Market Size Estimate/Industry Potential

The Indian household on an average saves more than our counterparts elsewhere. Savings rate in India is 29% as against the world average of 25%. But most of these savings (Close to 70%) are tied to physical assets or gold and this is set to change. My hypothesis is that real estate prices have gone up so dramatically in Tier-1 and Tier-2 cities that the average middle class Indian family is no more able to afford buying 1 or more than 1 property. The proportion of net financial assets in total household savings
has seen a sharp rise from 31% in Fiscal 2012 to 42% in Fiscal 2017.

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India is one of the least penetrated markets in the world. Penetration is typically measured as the AUM with Mutual funds to GDP. In India this is now at around 12%-13%.

This is nowhere near the level of penetration some of the more developed economies in the world have.

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And this will change, primarily because of 3-4 factors.

  1. Overall market expansion - % coverage of the overall population. Formalisation of the economy will make financial inclusiveness for a much larger population possible.
  2. Growth in financial assets as a % of overall household savings will increase due to the rather slim investment opportunities that gold and real estate offer.
  3. GDP per capita will grow - Meaning people will get paid more and hence save more.
  4. Awareness of financial products and the long term wealth creation potential of equity oriented schemes will increase.

Should the Indian economy continue to grow at 7% levels for the next 10 years, GDP of India will be about USD$5 Trillion in 2025. Assuming the penetration of mutual funds increase from 13% of GDP to 25% of GDP, total AUM under this industry will be $1.25Trillion or about 85 Trillion rupees (4X growth compared to where we are today). That is a CAGR of 15% over the next 10 years.

Profitability Drivers

  1. From a unit economics perspective, equity funds earn the highest fee. So larger the share of equity oriented AUM, better the profitability. This table below from the Crisil research report gives an excellent view. PMS funds also earn a significantly higher fee compared to mutual funds. However, even for the largest player today PMS is only about 2.5% of the overall portfolio. So I do not know the exact extent to which PMS services can impact revenue growth/profitability growth for a mid to large sized player.

HDFC AMC leads the pack in terms of profitability simply because of the better mix between equity and non-equity oriented schemes. While HDFC’s overall market share is about 13%, it has the highest market share of 17% of actively managed equity funds.

  1. The mix between the type of customers the AMC has plays a key role as well in determining profitability. Institutional customers tend to have shorter holding periods and are mostly invested in money market funds or short term debt funds (which makes sense because corporate funds will need to be called back when there is a business requirement). Individual investors on the other end are invested for the long run.

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  1. Source of funds play a very important role in determining cost structure of these businesses. Direct funds tend to have no intermediaries/distributors and hence require no sales commissions to be paid out. However, distribution network are vital to expanding reach and to create brand recognition.

Risks

The fundamentals of the asset management industry is especially prone to the vagaries of Mr.Market. The industry primarily makes money out of fees on the AUM.

  1. Any under performance at an individual company level/de-rating of funds will lead to reduction in AUM and consequently reduction in overall revenue/profits.
  2. At an industry level, bear markets typically cause investors to pull out of equity markets and run for safety. So from a correlation perspective, AMCs will have a perfect Beta score of 1 with the index. But over a period of 25 years, the trend is only one way.
  3. Congruence of interests - I have read reports that ICICI Pru AMC bailed out the listing of ICICI securities and this is an area of grave concern. Incidents like this can have adverse effects from 2 perspectives - a)Consumer confidence goes down b)The industry opens itself up to a lot of scrutiny by the regulator.
  4. Speaking of regulator, government agencies can be notoriously active. They have however done good things over the last several years by influencing organisations like EPFO to invest in equity schemes (15% of their total assets), incentivising AMC’s to attract funds from B-15/B-30 (Top-15/Beyond-15 cities) by charging a higher fee, enforcing investments on creating awareness in the market by mandating AMCs’ spend etc.

I am still researching on what makes individual businesses successful in this space and what some of the long term critical success factors are (right to play, right to win). I will post updates soon after. Comments/thoughts/additional research/insights most welcome. I am a novice investor, so any help is appreciated.

Thanks!

Note : There are only 2 listed companies in pure play asset management today, Reliance AMC (which got listed recently) and HDFC AMC (which gets listed on the 6th of August). IIFL is going to list their 3 arms as three different companies on the exchange this year and their AMC is one of them. So not a lot of players are public. However, this might also change.

Disclaimer : This is not an investment advise, I have no investments either in any of the above mutual funds or on any of the listed AMCs.

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Another risk factor to be considered is the rise of low cost index funds. As index churning process becomes more and more efficient, index funds have serious potential to damage the actively managed fund industry, along with its profitability. The impact and success of passive investment is already visible in western markets.

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From my understanding of the industry, AUMs grow on account of two major reasons.

  • Fresh inflows by investors (Net) and
  • Increase in value of existing AUM

I agree with you that in a bear market, fresh inflows by investors will decline. However, the existing AUM will also fall due to fall in share prices. Therefore, the beta would be more than 1.

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Stallion Asset Blog on HDFC AMC IPO

Given that AMCs are trading at such premium valuations especially HDFC AMC, is Edelweiss Financial Services a good play on this industry? It has AuA (wealth mgmt) of 96,000cr and AuM (Asset Mgmt) of 29,000cr.
Besides, it is available at a P/B of 3.3 currently and brings along with it a robust credit business and future upside in the insurance business.

ridiculously short write up from an advisory …

Edelweiss still remains primarily a Credit business with a small percentage of profits contributed by Wealth management. Same is the case with IIFL, AB Capital, Kotak etc although IIFL plans to de merge its wealth management subsidiary.

Well, not anymore if you look into the details:
a. Asset mgmt: AUMs have grown 10x from 2,800cr to 29,200cr in just 3yrs
b. Wealth mgmt: AUAs have grown 20x from 4,800cr to 96,300cr in 6yrs
The company is focusing on expanding these businesses significantly in the next 3-4yrs, which is evident from the number of people it is hiring specifically for these two segments.

Spent some sunday time understanding the asset and wealth management industry and likely future trends. Sharing some learnings

  1. In the US, Expense ratios of Mutual Funds have fallen considerably since 2000. Source - http://www.icifactbook.org/ch6/18_fb_ch6
    In equity MF, expense ratios have fallen by as much as 40% since 2000

  2. Similarly in the US, ETFs and low cost Funds are becoming more popular, further reducing earnings of Asset Managers

  3. Currently in India, a large share of the Asset management industry profits are pocketed by Distributors (Brokers) who normally take up 0.5-1.5% of Regular Mutual Fund Plans in the first year and upto 1.25% as trail commission in the future. Thats nearly 50% of total the expense ratio of the Regular Plans. Source - https://www.fundsupermart.co.in/main/download/consolidated%20comission%20rate.pdf

I was surprised to know that in FY18, HDFC Bank as a distributor earned Rs. 641 crores as distribution commission for selling MF schemes to its customers. Thats 60% of HDFC AMC’s annual PBT of Rs. 1063 crores in FY18
https://www.amfiindia.com/commission-disclosure

  1. Now if you follow the news SEBI is already acting to promote Direct MF plans and reduce expense ratios. I think going forward, distributors and commission agents will get lower commissions and the industry profits would shift towards the people actually responsible for earning returns i.e. Asset Management Companies.

  2. Paytm is an app which is there on most smartphones in India and Paytm has started selling Direct Mutual Funds through this app. This is one more reason I feel why commission income of distributors will go down

  3. Next generation of customers will have easy access to information through technology and would not like going through brokers for buying financial products

  4. Competition among AMCs, PMS would ensure that no one player is able to charge differential price compared to others (Very little Moat). The most profitable player would likely be the most efficient one (Like in a commodity business).

Disc - Invested in HDFC AMC

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Commission % are set to reduce as the market becomes more efficient and more players come in. But this will easily be offset by…

A. Sensex touching 100000 is certain but a distant reality. This will result in Increased revenues due to increasing volumes and increasing index numbers both.

B. After demonetization, the people are flush with cash in the bank, this will certainly result in Increased volumes.

Wasn’t aware that we had a thread on this. In the recent annual VP meet I’d presented on this sector - specifically Asset Management & Wealth Management.

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Have done a bit of work that will be helpful in understanding the history of the industry.

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Nippon life
Key takeaways

Post transaction (Nippon taking over):

 Running a campaign to advertise the brand change.
 Business processes continues to remain the same while customer experience has
improved with Nippon’s expertise.
 As a direct subsidiary, rather than a JV partner of Nippon, the company is likely to
get more benefit from resources of Nippon Life.
 Long-term commitment from global CEO of Nippon to the mutual fund/asset
management industry in India.

Growth

 Vision of the company is to have the highest proportion of retail assets as a
proportion of total.
 The company works across a spectrum of investors—corporates/HNIs & retail.
 Corporates and HNIs cover 60-65% of AUM.
 Focused on getting AUM back to where it was 18 months ago. Operating leverage
benefits will kick in as AUM grows.
 Corporates have started to invest in their folios again as relationships are re-
established with change in brand.
 HNIs and distributors had started to move out of RNAM even though they were
aware that the money is ring-fenced. However, now it is coming back gradually.
 Interest for passive fund is on the rise due to several family offices and large
investors.

Business operations

 Plans to maintain share of equity AUM at 40-45%.
 Loyal base of Independent Financial Advisors (IFA) continue selling products
offered by the company in the absence of a bank parent.
 Investment team (debt as well as equity) is being expanded.
 Stated policy of dividend payout ratio in the range of 70-90%.

A report on the AMC industry by Prabhdas Lilladher.

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